The world economy has finally bottomed out. The JPMorgan Global Purchasing Managers’ Index (PMI) for manufacturing was 50 for July, which means that global manufacturing neither expanded nor contracted during the month. A reading above 50 signifies expansion from the previous month, while one below 50 indicates a contraction. This is the first time since May 2008 that global manufacturing has stopped contracting.
That’s not all. The global manufacturing output index, a sub-index of the Global manufacturing PMI, expanded for the second month, with its reading rising from 50.4 in June to 54.3 in July.
Best of all, the new orders sub-index, a harbinger of future output because today’s new orders are tomorrow’s production, moved up to 53.3 in July from 49.1 in June. India, China, the UK, Japan, Turkey and Sweden all showed readings above 50 during July, indicating their manufacturing sectors have started expanding again.
The US and the euro zone countries also moved closer to stability. In the US, while the overall manufacturing PMI was at 48.9, the production sub-index was at a solid 57.9 and the new orders sub-index came in at 55.3, both showing expansion.
David Hensley, director of global economics coordination at JPMorgan, said the “rebound is likely to gain traction in the coming months, as the forward-looking orders-to-inventory ratio surged to a record high”. The point that inventories have been slashed to very low levels during the downturn has also been emphasized by other analysts, which is their basis for a V-shaped recovery, as companies restock their shelves.
A rollercoaster ride for the Global manufacturing PMI. Ahmed Raza Khan / Mint
A recent note on global investment strategy by Credit Suisse Group AG points out that the drop in inventories globally has been extremely strong and the ratio of inventories to new orders is consistent with industrial production growth bouncing back to around 10% year on year.
True, the global economy isn’t just about manufacturing and the PMI for global services for July is not out yet. But at 47.4 in June, this index was higher than the manufacturing PMI during that month and the odds are that it, too, should cross 50 either in July or August. The signal is clear: The world economy is once again on the road to expansion.
There are plenty of other signals showing improvement. Global stock markets are on a tear, with the S&P 500 index closing above 1,000 points for the first time since November. Three-month dollar Libor (London interbank offered rate) rates are now being fixed at record lows. The spreads emerging market bonds have to pay over US treasurys are back to the levels they were at last September. The CBOE (Chicago Board of Options Exchange) Volatility Index, or VIX, is back to the levels it was at last October. All these are signs that the financial markets have stabilized.
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In the US, the Case-Shiller Price Index for housing for May shows a significant improvement, indicating the bottom may be near for the all-important US housing market. Second quarter US GDP (gross domestic product) came in at -1%, better than expected.
Chinese second quarter GDP growth was a high 7.9%. What’s more, it’s likely to get better, because as the effect of the low base of last year’s fourth quarter kicks in, growth will appear even stronger.
Ben Bernanke and the Union of Central Bankers and Governments have pulled it off and extracted the world economy from the hole it was in. So is the Great Recession finally over? Has the problem been solved by throwing massive amounts of money at it? Not yet. The world economy has been propped up almost solely by government spending. Unprecedented monetary easing, together with a huge dose of fiscal stimulus, has kept the economy buoyant. Writes US economist James Hamilton, “Had it not been for the positive contribution from falling imports and increasing government spending, the Q2 (GDP growth) number would have been -4.3% instead of -1%.”
Of course, government spending and ultra-loose monetary policy is necessary till the recovery is firmly in place. But as the economy recovers and credit growth picks up, that will be the tricky part. All the more so as plenty of voices are warning the crisis is not over yet. Deutsche Bank chief executive Josef Ackermann recently said banks will soon be hit by the next wave of defaults. Pacific Investment Management Co. Llc’s Bill Gross has warned of years of deleveraging, consumer retrenchment and below-normal growth.
The dilemma for central banks and the governments is that if they let interest rates rise, or withdraw the stimulus too soon, the recovery could splutter. On the other hand, if they keep the moolah flowing, they run the risk of igniting a runaway bubble in asset prices.
They could also be flirting with stagflation. As economist Andy Xie put it: “Before the financial crisis, the global economy experienced a nearly 4% growth rate with half as much inflation. In the coming five years, I think the best scenario will be half the growth and twice the inflation.” But then, those problems are still a few quarters away.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org